Horace Mann Educators Corporation — Q1 2016 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2016; comparisons are with the three months ended March 31, 2015 unless otherwise stated. Horace Mann sells property and casualty insurance, retirement annuities and life insurance, primarily to public-school educators and their families. The interim financial statements were reviewed by KPMG, not audited; KPMG reported no material modifications were needed for GAAP conformity.
Financial performance and position
| Metric | Q1 2016 | Q1 2015 / prior date |
|---|---|---|
| Total revenue | $271.3 million | $270.1 million |
| Premiums and contract charges earned | $185.5 million | $179.7 million |
| Net investment income | $84.7 million | $83.3 million |
| Net realized investment gains (losses) | $(0.2) million | $6.1 million |
| Net income | $25.2 million | $34.3 million |
| Diluted EPS | $0.61 | $0.81 |
| Operating cash flow | $77.1 million | $67.3 million |
- Net income fell 26.5%; the decline reflected weaker property and casualty and annuity results, lower realized investment results, and a $3.9 million deterioration in corporate and other. After-tax realized investment results shifted from a $4.0 million gain to a $0.4 million loss.
- Property and casualty net income was $13.8 million, down $3.8 million; annuity net income was $10.6 million, down $1.9 million; life net income was $3.9 million, up $0.5 million. The P&C combined ratio rose to 93.8% from 90.4%.
- Premiums written and contract deposits declined 7.4% to $283.2 million, mainly because annuity deposits fell 20.7%; P&C premiums written rose 4.4% and life premiums and deposits rose 3.0%. Earned premiums and charges increased 3.2%.
- Operating expenses increased 19.2% to $42.8 million, including customer-service, technology and infrastructure spending; the prior-year comparison benefited from a reduction in incentive compensation expense.
- At March 31, total assets were $10.23 billion and shareholders’ equity was $1.34 billion. Cash was $50.5 million, up from $15.5 million at year-end. Total investments were $7.82 billion; fixed maturities and equity securities had $432.9 million of pretax net unrealized gains.
- Long-term debt was $247.0 million, with no short-term borrowings and no balance on the $150 million revolving credit facility. Debt was 18.5% of capital excluding unrealized investment gains and losses (15.6% including them), below the stated 25% long-term target.
- Book value per share was $33.11; excluding investment fair-value adjustments, it was $27.05. The company paid $11.1 million of dividends and repurchased 474,277 shares for $14.5 million during the quarter.
Material changes and management commentary
- P&C results faced higher automobile loss severity and catastrophe costs, partly offset by improving homeowners non-catastrophe experience. Catastrophe losses were $12.7 million versus $10.5 million; favorable prior-year reserve development was $2.0 million versus $4.0 million.
- The annuity net interest spread was 183 basis points versus 194 basis points a year earlier. Management cited low interest rates and lower alternative investment returns. About 86% of deferred annuity account values were at their minimum guaranteed rate, limiting scope for further crediting-rate reductions.
- The investment portfolio’s average pretax yield declined to 4.99% from 5.16%. Management said tighter credit spreads and lower Treasury rates raised unrealized gains during the quarter. Gross unrealized losses covered 22.5% of fixed-maturity and equity fair value at March 31, versus 35.1% at year-end; management considered the losses temporary but noted circumstances could require future impairment recognition.
- Q1 2016 net realized results included $3.7 million of impairment charges, largely involving Puerto Rico and energy-sector securities. The prior-year quarter included $2.3 million of impairment charges, largely energy-related.
- Premiums and deposits in Q1 2015 included non-recurring deposits associated with changes to employee retirement savings plans, affecting year-over-year annuity comparisons. The 2015 quarter also included an immaterial out-of-period compensation adjustment that benefited segment results.
Outlook, risks and contingencies
- Management projected 2016 full-year net income, before realized investment gains and losses, of $2.15–$2.35 per diluted share. It expected continued underlying P&C combined-ratio improvement, partly offset by lower favorable reserve development, annuity and life interest-rate pressure, and higher modernization-related expenses.
- Management expected portfolio yield to decline about 10 basis points over 2016, and the annuity net interest spread to move from 184 basis points in 2015 to the low 170s. It also expected 2016 catastrophe losses below 2015 levels.
- Key exposures include sustained low interest rates and reinvestment risk, market and credit valuation changes, catastrophe frequency and severity, claims-reserve estimation, and the ability to obtain affordable reinsurance. Six of the ten largest P&C states were identified as catastrophe-prone.
- The filing discusses the Department of Labor fiduciary rule, generally applicable beginning April 2017, as a potential source of added costs, distribution and compensation changes, and reduced IRA business. Potential SEC fiduciary-standard rulemaking was also identified as a risk.
- Unfunded investment-purchase and lending commitments totaled $155.2 million. The filing states that operating cash flow should be adequate for operating needs over the next 12 months; subsidiary dividends remain subject to regulatory limits.
Most important facts for investors to verify
- Whether automobile loss severity, catastrophe losses and reserve development evolve as management anticipated, and how the combined ratio trends.
- Whether annuity spreads and investment yields meet guidance amid low rates and minimum-rate guarantees.
- Whether the $2.15–$2.35 per-share outlook remains achievable after investment results, operating expenses and segment performance.
- Whether investment impairments, unrealized losses, credit quality and reinsurance exposures materially change.
- How annuity deposit trends normalize after the prior-year non-recurring deposits, and whether P&C premium growth and policy retention continue.
- The effects of fiduciary-rule implementation on annuity distribution, agent economics and IRA-related business.